Debt’s Political Fix Ahilan Kadirgamar, Shafiya Rafaithu and Yathursha Ulakentheran

The victory of Anura Kumara Dissanayake in September’s Sri Lankan presidential election shocked the world. Dissanayake comes from the Janatha Vimukthi Peramuna (JVP)—the party of the rural poor youth behind two bloody insurrections in 1971 and 1988–1989, the latter of which led to the deaths of between 40,000 and 70,000 people. The JVP’s leadership was physically destroyed in the last insurrection, but over the past few decades, the party has rebranded itself in the political mainstream by forming a broader coalition, the National People’s Power (NPP), consisting of fragments of other left parties and professionals. The NPP wooed the middle classes with promises to end the corruption of previous administrations, blaming them for Sri Lanka’s first and only default on external debt. After an unprecedented external debt crisis, the resultant shortage of imported essential goods, and tremendous protests two years ago, the NPP won its historic bid to capture state power.

Unlike his predecessors Gotabaya Rajapaksa and Ranil Wickremesinghe, Dissanayake does not belong to a known political family, and his party does not come from a lineage of ruling parties. Having campaigned and failed with a meager 3 percent of the vote in 2019, Dissanayake’s rapid accession to power from obscurity has generated a wave of great expectations for reform in the island nation. Despite its popularity, the NPP has yet to deliver a clear economic platform; the party’s success was mainly borne from anti-corruption discourse and an anti-incumbent call for change. Therein lies the NPP’s political challenge: the new government must meet voters’ economic aspirations without having prepared them for the country’s economic trajectory, with an ongoing depression likely to last for years.

A stealthy maneuver led by the International Monetary Fund (IMF) and the creditors has further imperiled these aspirations. Days before the election, Wickremesinghe entered into two agreements to restructure a portion of Sri Lanka’s $37 billion in external debt: $12.5 billion with private bondholders and $3.3 billion with the China Development Bank. Before the new government had even fully formed, the hopes of a more just and sustainable resolution to the ongoing debt crisis were dashed the IMF and the creditors insisted that Dissanayake accept an unfair bond deal. The Finance Ministry has announced that the deal would be finalized within two months, and Dissanayake’s publicized efforts to renegotiate the terms has since shaped the early days of his government. This politically brokered debt resolution is not only likely to lead Sri Lanka to another default, but it also constrains future development and growth, not to mention the hope of social improvement.

Sri Lanka provides many lessons for similar small states swayed by the glacial shift of a mounting debt crisis in the 2020s. The unfolding consequences of the long drawn financial crisis of 2008 and the post-pandemic years of global unraveling with wars and economic volatility have undermined financial stability, while nonetheless prolonging the hegemony of finance capital. The 2020s are proving to be the decade in which the lethal power of great nations is destabilizing the international order. The architecture of elite financial extraction is now showing signs of stress.

It is amid these geopolitical tensions and conflicts in places as far as the Middle East, Africa, and the Indian Ocean that a broken financial order finds political fixes against the desperate resistance of people long trammeled by its exploitation. In these moves to reassert dominance, the main protagonist is now again the IMF. The Fund has managed to muscle smaller states—whether it be Ghana, Zambia, Kenya, or Sri Lanka—into its programs of further liberalization.

The IMF claims that the debt crisis is one of liquidity, requiring money thrown at the problem, rather than one of solvency, compelling debt forgiveness that should be absorbed by losses to the financiers. In Sri Lanka, this political fix is forcing a new government elected on the promise of change to accept the IMF’s debt restructuring program. A country that two years ago defaulted on its debt for the first time in its seventy-year history has now been set on a path of repeated debt crises.

Crisis and the IMF

Sri Lanka’s economic crisis had been long in the making, going back to liberalization policies in the late 1970s, and accelerated by a second wave of neoliberal policies after the end of its civil war in 2009. During the pandemic, foreign remittances and tourist earnings came to a halt, depleting Sri Lanka’s foreign reserves. In early 2022, commodity prices rose with the war in Ukraine, and the Sri Lankan government, unable to roll-over its external loans, defaulted on its sovereign-debt payments. Fuel and food shortages due to lack of foreign exchange for imports, as well as anger at the Rajapaksa government’s corruption scandals, sparked sustained protests. President Gotabaya Rajapaksa appointed Ranil Wickremesinghe as Prime Minister in May 2022 to distance himself from his family in power. When protestors finally chased away Rajapaksa, the parliament dominated by his party appointed Ranil Wickremesinghe as President in July 2022.

In early 2022, amid this political and economic crisis, Sri Lanka turned to the IMF and began implementing its recommendations. Following an unprecedented default in April 2022, the government publicly called for immediate IMF support including debt restructuring, but it was only in March 2023 that the Executive Board of the IMF approved the Extended Fund Facility (EFF). The IMF claims that the EFF program is meant to encourage growth and debt sustainability, but the measures imposed are familiar: they prioritize repayments to creditors and placate international financial capital. In order to reach the IMF’s goals, the EFF program set two major targets.

The first target is a high Primary Budget Surplus government revenues minus expenditures excluding debt payments—of 2.3 percent of GDP. This encourages high taxation, including on essentials, to raise revenue, in addition to austerity measures that burden those already reeling under an economic crisis. This high budget surplus target does not allow stimulus for growth during a devastating economic depression. Many prominent economists have vehemently criticized this target, which is 3 percentage points higher than Sri Lanka’s best-performing peer countries.1

In effect, the IMF demands that the Sri Lankan people tighten their belts to be able to repay private creditors. This comes at a time when households are spending more than 60 percent of their total expenditure on food, resulting in insufficient funds to cover other essentials, including healthcare, education, and utilities.2 IMF conditionalities have introduced market pricing for energy, leading 1.3 million households to suffer cuts to electricity service and reducing the country’s fuel consumption by 50 percent. Total cement consumption dropped by 32.5 percent, evidence of the contraction in the construction sector.3 This sector typically employs informal workers, particularly during the off-seasons in agriculture and fisheries, providing much needed household income. Amid this severe economic contraction,4 the IMF also expects the government to reduce public spending necessary to provide relief to the people.5

Secondly, the IMF demands debt restructuring with creditors to achieve debt sustainability. The IMF’s Debt Sustainability Analysis (DSA) combines both external and domestic debt, even though it is external debt that Sri Lanka defaulted on due to lack of foreign exchange. If domestic debt were considered separately, the government would have room for deficit financing by borrowing locally in rupees. Indeed, such domestic borrowing is necessary to stimulate growth through state investment. The domestic debt restructuring process, pressured by the powerful international creditors, will dispossess working people of close to half their retirement funds over the next decade and a half.

The IMF’s analysis assumes that the country can spend 4.5 percent of GDP in external debt servicing each year after the end of the IMF program in 2027. This could be as high as $4.5 billion in 2027 and greater each year following, equivalent to 30 percent of government revenues and utilizing 30 percent of export earnings for payments in foreign currency. Furthermore, the IMF has set the goal of borrowing from the international capital markets, the equivalent of 1.8 percent of GDP in new International Sovereign Bonds each year after the program. That means about 40 percent of the external debt servicing will depend on new bonds, which are likely to be extremely high interest loans—given the high level of total debt stock at that time amounting to 95 percent of GDP and given the recent history of default. The reality is that Sri Lanka may not be able to float such new bonds at repayable interest rates. If another global shock increases the import prices of essentials such as fuel, Sri Lanka is likely to default again in the years following the IMF program.

Regime change and the bond deal

The IMF program worked through its logic of austerity and dispossession under the authoritarian regime of President Ranil Wickremesinghe, which unleashed tremendous repression against protestors to push through stabilization policies. For two years afterwards, Sri Lankans waited patiently to bring about change through the presidential elections. The election of President Dissanayake signals that the country’s working people are demanding an end to their hardship.

In the weeks before Dissanayake’s election, the international press had labeled him a Marxist, even though his party had moved to the center since the 1990s. Western discourse claiming that a Marxist could not run an economy or work with the IMF placed political pressure on Dissanayake to embrace the Western view and swallow the IMF program. After his inauguration, diplomats and international officials meeting the newly elected President, among them representatives of international financial institutions like the Asian Development Bank (ADB) and the World Bank, conveyed the same message. During these visits, Krishna Srinivasan, Director for the IMF’s Asia Pacific Department, emphasized that Sri Lanka needed to protect its “hard-won gains” through the IMF program in order to gain further funding.

In parallel to such discourse around the elections, a more sinister process of negotiations was underway between bondholders and the previous government. Desperate to win the election, the Wickremesinghe government reached an Agreement in Principle with bondholders just two days before the presidential election. Wickremesinghe’s gamble was that the triumphant claim of lifting the country out of bankruptcy would draw votes.

The election thus worked in favor of the creditors, if not for Wickremesinghe. The IMF succeeded in extracting obligations—high external debt servicing and total public debt to GDP targets—from Sri Lanka’s weak negotiating position before its own political process could reflect public opinion. Although Sri Lanka is currently in default and will not be repaying debt to private and bilateral creditors, as per the current IMF program, the recent deal will lead to issuing bonds to cover past due interest with repayment during 2024–2028.6 There is only a small reduction in the debt stock, from $12.55 billion to $11.83 billion.7 In addition, a consent fee of 1.8 percent is also set to be paid up-front. With interest payments of $1.7 billion on overdue bonds over the next three years, the bond deal burdens Sri Lanka with a future of unsustainable debt.

Yet most egregious are the instruments that will lock Sri Lanka into this future: “Macro-Linked Bonds” (MLBs). This external debt restructuring agreement arbitrated by the IMF and championed by countries such as India, which early on provided financial support to Sri Lanka for the purchase of essentials during the foreign exchange crisis,8 ensures that the bondholders earn much higher profits when the performance of the economy improves: payments of additional or less principal and interest based on indicators such as GDP growth. For Sri Lanka, the MLBs will require more in principal and interest payments to the bondholders over the next decade if the GDP in dollar terms grows higher than the IMF set targets during 2025–2027. The country will be punished if rapid growth or local currency appreciation lead to a higher dollar GDP.

Myth of the IMF bailout

This shameful bond deal has been characterized as a necessary step of the IMF “bailout,” which would ultimately lead Sri Lanka on the path of prosperity. In almost every developing country, an IMF program is dubbed as a “bailout.” But what does such a bailout entail?

Firstly, under the EFF program, the IMF is providing Sri Lanka with $3 billion peanuts compared to the foreign earnings of the country. On monthly terms, the so-called bailout amounts to just $60 million until 2027. Meanwhile, Sri Lanka’s foreign earnings every month now amount to around $1.8 billion, accruing from exploited workers generating foreign earnings through garments and tea exports, migrant remittances, and tourism. Clearly, this is not a bailout!

Secondly, the interest Sri Lanka will be paying to the IMF in the next ten years amounts to $2 billion.9 The IMF’s annual interest rates until recently for a country like Sri Lanka was a minimum of 5.104 percent and can go as high as 8.604 percent with disbursements.10 In October 2024, in response to sustained campaigns by progressive economists and international actors, the IMF announced a reduction to some of its surcharges, meaning that interest rates are likely to come down in the future.11

While the bondholders, made up of the hedge funds and other financial institutions, have shafted Sri Lanka with extractive annual interest rates on the order of 6 percent to 9 percent, the IMF is also culpable, as the Fund’s support is contingent on Sri Lanka capitulating to international bondholders’ proposals for debt restructuring. Furthermore, as an arbiter of debt restructuring, the IMF refuses to restructure sovereign debt owed to it. There is clearly a conflict of interest in the IMF’s role as a lender and an arbiter. Indeed, there are few checks and balances in existing global institutions controlled by the US.

With austerity measures undermining production and growth, the IMF’s proposal to exit the crisis is also flawed. These powerful economic actors argue that the fickle tourism sector is the remedy for economic misery. When all other forms of economic development fail, tourism dependent on both imports and patrons from wealthy countries is the catch-all solution.

Those in favor of the IMF program argue that it will unlock funds from other multilateral institutions, such as the World Bank and the ADB, as well as other bilateral creditors. However, such funds are often tied to infrastructure, including tourism-centered development, as well as other projects that in Sri Lanka’s recent history have failed to provide returns. Major projects, including highways and ports, characteristic of the high growth and debt-splurge years a decade back, have not led to the promised increase in production, but rather economic trouble.

Widespread debt distress and alternatives

Sri Lanka is one of over seventy developing countries currently in debt distress. In the late 2000s, many countries in the global South were enticed into borrowing from the international capital markets where, like in Sri Lanka, they began floating high interest International Sovereign Bonds. This was a time when global financiers needed markets to provide high returns with near zero interest rates in the West due to the Global Financial Crisis. In Africa, for example, the 2014 Africa Rising conference between the Government of Mozambique and the IMF, with its exuberant projections of high growth in the continent, led to a spree of borrowing. In countries like Sri Lanka, the IMF encouraged commercial borrowing, with their DSAs warning nothing about the consequences.

When countries become entrapped by such borrowing, bondholders alongside a complicit IMF—find innovative ways to avoid debt relief. The MLB experiment in Sri Lanka may become the norm in future debt resolutions, ensuring accelerated repayment to the creditors. Sri Lanka’s recent Agreement in Principle also allows for the law underlying the contracts to be moved to another jurisdiction to avoid constraints by legislators to ensure debt restructuring in favor of the debtors. While 50 percent of sovereign commercial borrowing is under New York law, and with moves towards a new Sovereign Debt Stability Act to restrain bondholders, the Sri Lankan agreement provides for change of jurisdiction to Delaware or English law.12

Repeated defaults across the world have instilled little confidence in the IMF approach to debt resolution. The current wave of debt distress in the 2020s is now being dismissed as one of a liquidity crisis as opposed to a deep-seated solvency crisis that requires extensive debt forgiveness. Amid periods of social uprising and political strife that often are the result of the IMF’s own policies, political fixes like the one seen in Sri Lanka are being deployed across the global South, delaying a long-term remedy. The burden is ultimately transferred to the working people and concealed by a “bailout.” Backed by the IMF, bondholders, and domestic elites, these political fixes push democratically elected governments to accept regressive deals, locking them into a future of external constraints undermining national economic policy-making.

To avoid repeated debt crises, a reformed global financial system must adopt new avenues for development financing. Will regime changes in countries like Sri Lanka result in more political fixes, with powerful international actors ganging up against smaller states? Or could such democratically elected progressive regimes finally form a global South debtor’s coalition to challenge the IMF and the creditors?

Footnotes